Put your 401(k) to the test

Does your 401(k) have the best and latest features?

The debate continues to rage over which is better: a traditional defined-benefit plan or a defined-contribution plan, as in 401(k) and 403(b) plans.

In reality, fewer and fewer workers are likely to have a traditional pension plan—which many view as the most “efficient” type of retirement plan—and more and more people will have a defined-contribution plan.

And so the better debate to have would be about what features a best-in-class 401(k) plan should have. After all, if you’re going to have a 401(k) plan it might as well be a good one. But what features should it have?

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Well, according to at least one firm, it’s a bit of a mashup—the best of what a defined-benefit plan has to offer combined with the best of what a defined-contribution should offer. “If you design a defined-contribution plan that uses the same factors that make defined-benefit plans efficient, you get an efficient defined-contribution plan,” said Donald Fuerst, a senior pension fellow at the American Academy of Actuaries.

Mandatory or default investment in automatic asset allocation vehicles, such as target-date funds

Limited or no borrowing from the plan

Annuitized benefit payments; and

Provision of objective education and advice for participants

Are these the features that truly make up the ideal defined contribution plan? These features—perhaps with the exception of annuitized benefit payments and limited or no borrowing—are in line with what other groups and plan sponsors say make up a great 401(k) plan. “They have it substantially right,” said Fuerst.

But before you head down to your human resource/employee benefit department demanding that your plan add these features, there are at least two things you should know. One, not everyone seems to agree with the elements on the list. And two, not everyone wants what’s on the list.

While it’s possible to design what the TIAA-CREF Institute views as an ideal 401(k) plan, Fuerst says he don’t see many of them. “This is not the type of plan that (employers) or employees seem to want,” he said. “(Employees) want investment control and lump sums.”

What everyone seems to agree on

In the main, experts seem to agree that 401(k) plans, best-in-class or not, ought to have mandatory participation or automatic enrollment, and adequate contribution rates.

What’s more, participants save on average just 6.8% of pay, according to 56th Annual Profit Sharing and 401(k) Survey from the Plan Sponsor Council of America (PSCA).

Plan sponsors and plan providers are moving in the right direction, but it’s still less than ideal. At the moment, 47.2% of plans now have an automatic enrollment feature and employees who participate in plans with automatic enrollment generally begin contributing at 3% of pay.

Ron Gebhardtsbauer, a professor at Pennsylvania State University, said enrolling workers at just 3% of pay is a disservice to employees, especially if they get stuck at the very-inadequate 3% of pay, and don’t even get the full employer match. “If employers are concerned about the cost of a higher default contribution, they can stretch their match by going to say 30% or 40% of the first 10% of pay,” he said.

And so what’s needed in a best-in-class 401(k) is an aggressive auto-escalation feature, advisers say. Currently, 57.9% of plans automatically increase the default deferral rates over time, according to the PSCA.

“If other private sector employers are shy about requiring employees to contribute enough, I’d use not only automatic enrollment, but also automatic escalation of the contribution up a percent or two of pay, when employees get pay increases,” said Gebhardtsbauer, who noted that the ERISA Advisory Council is discussing these very issues right now.

Others agree that workers need to save more than the default deferral. “The single most important issue in retirement savings today is that participants are not saving enough,” said Mike Alfred, the co-founder and CEO of BrightScope. “It isn’t that they’re not investing well, although that may be the case in a lot of plans. So, I think any feature that drives more participation and higher savings rates should be seriously considered.”

To be sure, advisers might quibble over what an adequate savings rate might be. It is likely to be different based on one’s age, savings goal, assets accumulated already, and the like. “But for most participants today, “adequate” probably means the maximum contribution, rather than 10%, because most people are way behind where they need to be,” said Alfred.

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